Prudential regulation

A ‘D to Z’ of current issues in Insurance Supervision

On 27 September the Bank of England published the text of a speech given by David Rule, Executive Director of Insurance Supervision, at the Bank of America Merrill Lynch 23rd Annual Financials CEO Conference in London. Mr Rule spoke on current issues relating to insurance supervision and in particular discussed the following:

  • an update on progress towards a global Insurance Capital Standard;
  • the UK market for Insurance-Linked Securities and the PRA’s new insurers unit;
  • the messages on underwriting and reserving in wholesale insurance and reinsurance markets from Anna Sweeney’s Dear CEO letter earlier this year;
  • capital management, market risk sensitivities and the Supervisory Statement on Financial Management and Planning by Insurers; and
  • the sensitivity of the capital surpluses of UK life insurers to various market movements and the consistency in disclosure of such sensitivities by insurers as well as of the drivers of changes in their capital positions over time.

The ‘D to Z’ was because he did not discuss Assets and in particular illiquid assets, Brexit or Climate change.
 

Regulatory transactions: Changes to notification and application forms – CP 21/18

On 1 October the PRA in a Consultation Paper (CP21/18) sets out its proposals for changes to various PRA forms relating to applications or notifications for regulatory transactions. The CP is relevant to all PRA-authorised firms as well as firms that have a qualifying holding, or which intend to acquire a qualifying holding in a PRA-authorised firm.

The proposals would make amendments to the following Parts of the PRA Rulebook:

  • Passporting - to collect passporting data set out by EIOPA in its ‘Decision on the collaboration of the insurance supervisory authorities’ and to change references to the ‘insurance mediation’ and the Insurance Mediation Directive (IMD) to refer instead to ‘insurance distribution’ and the Insurance Distribution Directive (IDD);
  • Change in Control - to improve the usability of the forms, and collect information that is otherwise requested separately by adding new questions to the forms;
  • Insurance Special Purpose Vehicles (ISPVs) - to update the Multi-arrangement Insurance Special Purpose Vehicle (MISPV) Assumption of New Risk Notification Form; and
  • Notifications.
Responses are requested by Thursday 1 November 2018.

Banks’ and insurers’ approaches to managing the financial risks of climate change – CP23/18

On 15 October the PRA published a Consultation Paper (CP23/18) seeking views on a draft Supervisory Statement (SS) on the enhancement of banks' and insurers' approaches to managing the financial risks from climate change. The purpose of the proposals is to set out how effective governance, risk management, scenario analysis, and disclosures may be applied by firms to address the financial risks from climate change.

The draft SS is intended to complement existing policy material and inform compliance with existing requirements in legislation and PRA rules. The PRA’s desired outcome is that firms take a strategic approach to managing the financial risks from climate change, taking into account current risks, those that can plausibly arise in the future, and identifying the actions required today to mitigate current and future financial risks. The draft SS sets out the PRA’s proposed expectations concerning how firms:
  • embed the consideration of the financial risks from climate change in their governance arrangements;
  • incorporate the financial risks from climate change into existing risk management practice;
  • use (long-term) scenario analysis to inform strategy setting and risk assessment and identification; and
  • develop an approach to disclosure on the financial risks from climate change.
Feedback must be received by 15 January 2019.

Solvency II: Supervisory approval for the volatility adjustment – PS22/18

On 17 October the PRA published a Policy Statement (PS22/18) giving feedback to responses to Consultation Paper (CP) 22/17 ‘Solvency II: Supervisory approval for the volatility adjustment’. The PS also contains the PRA’s updated Supervisory Statement (SS) 23/15 ‘Solvency II: supervisory approval for the volatility adjustment’.

In CP22/17 the PRA proposed to clarify its expectations in respect of insurance and reinsurance firms seeking approval to apply a volatility adjustment (VA). The PRA has made some changes to the draft policy but does not consider these to change the substance of its expectations. The changes provide additional clarification where requested, with one more substantive change to the endorsement of the application of the VA to make the process more streamlined.

The PS is relevant to insurance and reinsurance companies using or intending to use the volatility adjustment.

The expectations set out in the SS came into effect on the publication of the PS on 17 October 2018.

Solvency II: Internal models – modelling of the volatility adjustment – PS23/18

On 17 October the PRA published a Policy Statement (PS23/18) providing feedback on responses to Consultation Paper (CP) 9/18 ‘Solvency II: Internal models – modelling of the volatility adjustment’. 

The PS also contains the PRA’s final Supervisory Statement (SS) 9/18 ‘Solvency II: Internal models – modelling of the volatility adjustment’ which sets out the PRA’s expectations of internal model firms when determining the risks that might arise from the dynamic volatility adjustment (DVA) when calculating the solvency capital requirement (SCR). The PS also contains the amendments to SS17/16 ‘Solvency II: internal models – assessment, model change and the role of non-executive directors’.

In CP9/18 the PRA consulted on the possibility of allowing firms to apply DVA in internal models when calculating the SCR and the adoption of a new SS. The CP highlighted the areas that the PRA proposed firms considered in their internal model and model change applications when seeking approval to apply the DVA.

The PS is relevant to UK Solvency II firms and to the Society of Lloyd’s and its managing agents but is most relevant to firms with, or seeking, volatility adjustment (VA) approval and which use a full or partial internal model to determine the SCR, together with UK Solvency II firms that may develop a full or partial internal model in future.

Solvency II: Updates to internal model output reporting – PS24/18

On 17 October the PRA published a Policy Statement (PS24/18) providing feedback to responses to Consultation Paper (CP) 10/18 ‘Solvency II: Updates to internal model output reporting’. It also contains the PRA’s final policy, as follows: The PRA has made a number of minor amendments to the expectations and LOG files. The PRA considers that the changes continue to reduce the overall reporting burden on firms and provide further clarity on completion of the relevant templates. 

The PS is relevant to all UK Solvency II firms, and the Society of Lloyd’s in respect of each of their syndicates and in respect of outputs of the Lloyd’s internal model.

Solvency II: External audit of the public disclosure requirement – PS25/18

On 17 October the PRA published a Policy Statement (PS25/18) providing feedback to responses to its Consultation Paper (CP) 8/18 ‘Solvency II: external audit of the public disclosure requirement’. The PS also contains the PRA’s final policy, as follows: In CP8/18 the PRA proposed to remove the external audit requirement for the SFCRs of certain small Solvency II firms, and certain small Solvency II groups (collectively ‘small insurers’). The SFCR is the key public disclosure under Solvency II. The PRA received 22 responses which generally welcomed the  proposals to remove the audit requirement for small insurers. A number of observations and requests for clarification were made. Responses to comments are set out in Chapter 2 of the CP.

The PS finalises the rules for the SFCR audit exemption by defining a ‘small firm for external audit purposes’ as firms who meet a threshold of a firm risk metric ‘score’ based on reported gross written premiums (GWP) and best estimate liabilities (BEL). A ‘small firm for external audit purposes’ is a UK Solvency II firm with a score below a specific threshold, and ‘small group for external audit purposes’ is a group in which every UK Solvency II firm in the group is a small firm for external audit purposes.

The changes to the External Audit Part of the PRA Rulebook and the amendments to SS11/16 will be effective from Thursday 15 November 2018. Thus, for firms that have a financial year ending after 15 November 2018 and who fall into the definition of a ‘small firm for external audit purposes’ there is no longer a requirement for the SFCR to be audited. The detailed rules setting out the calculation of the score are set out in the PRA Rulebook: Solvency II Firms and Non-Authorised Persons: External Audit Amendments Instrument 2018 and also in the future version of the PRA Rulebook.

The PS is relevant to all UK Solvency II firms (including mutuals), auditors and users of Solvency and Financial Condition Reports (SFCRs).

Strengthening accountability: implementing the extension of the SM&CR to insurers – PS26/18

On 18 October, the PRA published a Policy Statement (PS26/18) setting out feedback on the responses to Consultation Paper (CP) 18/18 ‘Strengthening accountability: implementing the extension of the SM&CR to insurers’. The PS also provides a rule instrument with amendments to the final rules for the implementation of the extension of the Senior Managers and Certification Regime (SM&CR, ‘the regime’) to insurers; along with a technical correction to the Insurance General Application Part of the PRA Rulebook.

This PS should be read in conjunction with PRA PS15/18 ‘Strengthening individual accountability in insurance: Extension of the SM&CR to insurers’, and Financial Conduct Authority (FCA) PS18/15 ‘Extending the Senior Managers and Certification Regime to insurers – Feedback to CP17/26 and CP17/41 and near final rules’, along with the proposals in PRA CP20/18 ‘Strengthening accountability: implementing the extension of the SM&CR to insurers (Part 2)’.

The PS is relevant to all Solvency II insurance firms (UK Solvency II firms, the Society of Lloyd’s and managing agents, and third country (re)insurance branches), and to insurance special purpose vehicles (ISPVs), large non-Directive firms (NDFs), small NDFs and Swiss general insurers (collectively referred to as ‘insurers’). Some of the final amendments to rules are relevant to other PRA-regulated firms (Annex A, B and X in the Appendix to the PS).

The extended SM&CR for insurers will come into effect on Monday 10 December 2018, through the application of the commencement regulations that have been published by HM Treasury for the relevant amendments to Financial Services and Markets Act 2000 in the Bank of England and Financial Services Act 2016.

Following the publication of the commencement regulations by HM Treasury, the PRA published CP20/18 on 17 September with some further proposed consequential technical amendments to its rules to take effect on Monday 10 December 2018. These further consequential changes are not intended to make any substantive change to the final policy and rules in this PS. A further PS containing the final rules following the consultation in CP20/18 will be published before the commencement of the regime.

Occasional Consultation Paper – CP24/18

On 22 October the PPRA published an Occasional Consultation Paper (CP24/18) setting out proposed changes to the PRA Rulebook Parts, supervisory statements (SSs), statements of policy (SoPs) and forms.

The chapters contained in the CP, the Rulebook Parts, SSs, SoPs and forms they propose to change, and the appendices where the draft policy is set out, are listed in the table below.
 
Chapter Rulebook / SS / SoP / Form Appendix Proposed Implementation Date
Reporting – amendment to the Branch Return Incoming Firms and Third Country Firms Part

Branch Return Form
 
1



2
 
1 Jan 2019



Date of final PS
 
Ring fencing – imposition of financial penalties under section 142S of FSMA SoP ‘The PRA’s approach to enforcement: statutory statements of policy and procedure’ 3 Date of final PS
Written reports by external auditors to the PRA Auditors Part

SS1/16 ‘Written reports by external auditors to the PRA’
4

5
Date of final PS

Periods ending on 31 Dec 2018
Depositor protection – minor updates Depositor Protection Part 6 Date of final PS
Policyholder Protection Part – minor updates Policyholder Protection Part 7 Date of final PS
Reporting templates for calculating risk based levies to reflect the European Banking Authority’s (EBA) transition to FINREP taxonomy SoP ‘Calculating risk-based levies for the Financial Services Compensation Scheme deposits class’ 8 Date of final PS

This CP is relevant to all PRA-authorised firms.

Brexit: Changes to PRA Rulebook and onshored Binding Technical Standards – CP26/18

On 25 October as part of the Bank of England’s and the PRA’s preparations for Brexit the PRApublished a Consultation Paper (CP26/18) setting out its proposals to fix deficiencies arising from the UK’s withdrawal from the EU in the PRA Rulebook, and in relation to Binding Technical Standards (BTS) within the PRA’s remit that will be converted, or ‘onshored’, into UK law. The CP also sets out the PRA’s proposals on how existing non-binding PRA materials, including Supervisory Statements (SS), Statements of Policy (SoP), and the PRA approach documents should be read by firms when the UK leaves the EU. The changes proposed in the CP are amendments to ensure an operable legal framework after the UK leaves the EU.

This CP is published as part of the Bank of England’s (Bank) consultation package on amending financial services legislation under the European Union (Withdrawal) Act 2018 (the ‘Act’). As explained in CP25/18 ‘The Bank of England’s approach to amending financial services legislation under the European Union (Withdrawal) Act 2018’  (‘NtA approach CP’), HM Treasury intends to delegate a power, under the Act, to the financial services regulators (FCA, PRA, Bank and Payment Systems Regulator (PSR)) giving them responsibility for fixing deficiencies in onshored BTS. The delegated power can also be used by the regulators to amend deficiencies within their respective rules. Therefore, the PRA intends to make ‘EU Exit Instruments’ where appropriate, to prevent, remedy or mitigate any failure of the onshored BTS within the PRA’s remit or PRA rules to operate effectively, or any other deficiency in these BTS or PRA rules arising from the UK’s withdrawal from the EU.

As set out in the NtA approach CP, the changes proposed in the CP would take effect at 11:00pm on Friday 29 March 2019 only in the event that there is no Implementation Period. If the draft Withdrawal Agreement agreed between the UK and EU is ratified and the Implementation Period commences on Friday 29 March 2019, the proposed changes would not take effect until after the end of the Implementation Period. Further modifications to the PRA Rulebook and onshored BTS may be required to reflect any agreement that is reached between the UK and EU on their future relationship.

The CP is relevant to all firms authorised and regulated by the PRA, as well as firms that are expected to have deemed permission under the ‘Temporary Permissions Regime’ (TPR) or that seek to apply for PRA authorisation in future.

The consultation closes on 2 January 2019.

Good cop / Bad cop – Speech by Sam Woods

On 25 October, at the Mansion House City Banquet, Sam Woods, the Deputy Governor for Prudential Regulation and the Chief Executive of the PRA, described the two different roles the regulator often finds itself playing i.e. good cop and bad cop.

He highlighted a number of areas where the PRA has to be the bad cop such as ring-fencing of banks, accountability and the Senior Managers Regime, remuneration practices and internal models driving capital requirements. He identified these as areas of tension between firms and regulators in terms of the incentives of firms and regulators not being aligned and capable of causing a degree of tension.

Two areas where the regulator plays good cop are operational resilience and Brexit. In the case of operational resilience, Sam highlights that the regulatory framework is “thoroughly under-developed” when compared to that of financial resilience, not only in the UK but also internationally. Operational resilience matters more than ever with the emergence of cyber-attacks and customers accessing firms digitally. However, the PRA’s particular interest is where a lack of operational resilience could have an impact on the safety and soundness of firms and/or UK financial stability. On Brexit he encouraged forms to be working on their contingency plans and incoming EU27 firms to opt into the Temporary Permissions Regime. He also urged EU regulators to reciprocate the steps taken by the UK to make sure those insurance and derivative contracts written before Brexit can still be appropriately cleared and serviced after it.


charles.portsmouth@moorestephens.com